Volume 7 | Issue 1
Article 3
10-1-1965
P. ROTHSCHILD*
U.C.C. 3-502 (1) (b). The conditions of intermediate liability are !aches, funds
maintained with the drawee and subsequent insolvency, and written assignment.
U.C.C. 3-501(1) (b).
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65
discharged on the instrument for failure to observe conditions precedent. Therefore, aside from possible variations in the statute of limitations, there is no difficulty caused by' questions of whether conduct
by the holder of an instrument will discharge the acceptor on the
underlying obligation.
B. Intermediate Liability
I. Drawers of Checks
The Code provides for situations where necessary presentment or
notice of dishonor is delayed, without excuse, beyond the time when it
is due. In such cases, any drawer of a check payable at a bank (or of
a bank domiciled draft payable at a specified time), who is deprived
of funds he maintained at the bank because it became insolvent during
the delay, may discharge his liability to the holder by written assignment to the holder of his rights to those funds against the bank; but
the drawer (or the acceptor or maker) "is not otherwise discharged.""
(Emphasis added.) Since presentment for payment," notice of dishonor and necessary protest" are conditions precedent to the drawer's
liability, his liability is intermediate and he will be discharged only
when he is injured due to bank insolvency. For the Code to become
operative, there must be both an unexcused delay and an intervening insolvency.' In establishing the liability of a drawer, presentment of an
uncertified check within thirty days of its date, or the date of issue,
whichever is later, is presumed presentment within a reasonable time."
Consequently, if the check becomes "stale," an unexcused delay will
effect discharge to the extent of injury occasioned by bank insolvency.
Otherwise the "no harmno discharge" rule applies, and the drawer of
an uncertified check will remain liable on both the instrument and the
underlying obligation."
Section 186 of the Negotiable Instruments Law provides that "a
check must be presented for payment within a reasonable time after
its issue or the drawer will be discharged from liability thereon to the
extent of the loss caused by the delay." The difficulty with this section
is that it is sometimes impossible to determine the precise amount of
the loss caused until after liquidation of the bank. Further, the weight
3-502(1)(b).
is a demand instrument, and presentment for acceptance is not ordinarily
necessary. But see 11,C.C. 3-501 (when instrument requires presentment).
16 This is only "necessary to charge the drawer and indorsers of any draft which on
its face appears to be drawn or payable outside of the states and territories of the
United States and the District of Columbia." U.C.C. 3-501(3).
17 The provisions concerning waiver or excused presentment, found in U.C.C.
3-511, are presumed inapplicable for purposes of this article.
15 U.C.C. 3-503(2)(a).
16 See U.C.C. 4-404 (bank under no obligation to pay after six months).
14 U.C.C.
15 A check
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67
n nn-..
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69
a promissory note and refused to release him on the underlying obligation unless the laches of the creditor-holder has injured him, laches
of the creditor-holder has released the drawer of a draft on the underlying obligation whether or not he has been injured."
The Code has approached this problem through the contractual
liability of the parties. By increasing the drawer's liability on the instrument, and allowing discharge to the extent of injury, the Code has
increased his liability on the underlying obligation in cases where no
injury has occurred. Even though the Code holds the drawer of a draft
to a "no harmno discharge" rule, it has reversed the N.I.L. as to
"any indorser" by allowing discharge from liability on the underlying
obligation upon discharge on the instrument." In other words, the
drawer of a draft will be held to his underlying obligation where he
has not been "deprived of funds" by the drawee's insolvency," but
injury plays no part in the release of the indorser from his underlying
obligation.
C. Secondary Liability
Presentment for payment and notice of dishonor are necessary to
charge a secondary party, any indorser." Where either necessary presentment or notice of dishonor is delayed without excuse beyond the
time when due, any indorser is discharged on the instrument.' Since
any indorser will be discharged on the instrument if the holder fails
to observe the conditions precedent, his liability is "secondary" by
definition." The Code draws no distinction, other than what constitutes
a reasonable time for presentment," among indorsers of notes, checks
and drafts.
Dean Hawkland suggests" that the liability of a secondary party
47 Where creditor's laches has discharged the drawer on the instrument and
underlying obligation whether or not injury resulted, see cases cited note 35 supra. For
cases holding discharge only where injury (which in the absence of proof is presumed),
see McCrary v. Carrington, 35 Ala. 698 (1860); Smith v. Miller, 52 N.Y. 545 (1873). For
cases holding no release unless injury proven, see Dow v. Cowan, 23 F.2d 646 (8th Cir.
1927); Commercial Inv. Trust v. Lundgren-Wittensten Co., 173 Minn. 83, 216 N.W. 531
(1927).
48 "Where without excuse any necessary presentment . . is delayed beyond the
time when it is due (a) any endorser is discharged Ion the instrument] . . ." U.C.C:
3-502(1)(a). "[D]ischarge of the underlying obligor on the instrument also discharges
him on the obligation." U.C.C. 3-802(1) (b).
49 Note that U.C.C. 3-502, Comment 2 states that "where bank failure or other
insolvency of the drawee or payor has prevented him from receiving the benefit of
funds," the drawer (acceptor or maker) is "deprived of funds." However, this would not
include a situation where the drawer was insolvent.
5 U.C.C.
3 501(1) (b).
-
3-502(1)(a).
52 "Secondary liability
. exists when failure to observe conditions precedent
results in total discharge. . . ." Supra p. 64.
na U.C.C. 3-503,
54 Hawkland, supra note 10, at 39.
51
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OBLIGATION
71
U.C.C. 3-503(2)(b).
Where indorser is discharged on the underlying obligation, see McCrary v.
Carrington, supra note 47 (dictum) (third party instrument); Nixon v. Beard, 111
Ind. 137, 12 N.E. 131 (1887) (note taken from pre-existing indebtedness discharges
surety) ; Orange Screen Co. v. Holmes, 103 N.J.L. 560, 138 Atl. 105 (Sup. Ct. 1927)
(indorser discharged for holder's laches); Shipman v. Cook, supra note 35 (indorser
discharged for holder's laches); Dibble v. Richardson, 171 N.Y. 131, 63 N.E. 829 (1902)
(third party instrument taken); Cohen v. Rossmore, 225 App. Div. 300, 233 N.Y.S. 196
(1929) (surety released where not on renewal note); Hall v. Green, 14 Ohio 499, (1846)
(indorser discharged for laches of holder). For cases holding indorser not discharged on
underlying obligation, see Newell v. Newell, 213 Ind. 261, 12 N.E.2d 344 (1938)
(consideration for pre-existing debt or third party instrument); Bradway v. Groenendyke,
153 Ind. 508, 55 N.E. 434 (1899) (third party note); Droege v. Hoagland State Bank,
86 Ind. App. 236, 156 N.E. 592 (1927) (surety not discharged where renewal note
forged); Beech & Fuller Co. v. Lane, 75 Ind. App. 184, 129 N.E. 52 (1920) (renewal
note); Kimmel v. State, 75 Ind. App, 168, 128 N.E. 708 (1920) (surety not discharged
where note was collateral security); Emerine v. O'Brien, 36 Ohio St. 491 (1881) (surety
not released by forged indorsement on renewal note); City of Philadelphia v. Neil,
211 Pa. 353, 60 Atl. 1033 (1905) (dictum) (third party note); United States v. Hegeman,
204 Pa. 438, 54 Atl. 344 (1903) (renewal note taken); City of Philadelphia v. Stewart,
195 Pa. 309, 45 All. 1056 (1900) (third party note taken); American Nat'l Bank v.
National Fertilizer Co., 125 Tenn. 328, 143 S.W. 597 (1911) (third party note taken but
holder not guilty of laches).
62
63
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historic concept that a bill of exchange was originally used for payment.
Today, however, it is used as a "time instrument" to give the debtor an
extension of time on his obligation, and to place the creditor in a more
liquid position by availing him of the possibility of discounting the
bill." Thus, at common law, the concept of "collateral security" was
grounded on the functional use of a promissory note rather than its use
as a source of funds for payment and, consequently, this concept fell
into disuse when the function of a note was expanded. Under the Code,
variation based upon the type of instrument, i.e., the functional use, is
rejected by implication." But, the holder discharges any party to
the instrument if he unjustifiably impairs any collateral for the instrument given by the party, or on his behalf, or by any person against
whom he has a right of recourse."
2. Judicial Analysis of "Conditional Payment" Based on the Intent
of the Parties
The theory that the intent of the parties determines whether a
negotiable instrument is payment fails to simplify the question of
whether an action on the underlying obligation survives an action on
a negotiable instrument." Insofar as evidence is required to show
this intent, the courts vary from a restrictive attitude (the necessity
of an express agreement)," to a liberal one, which admits parol evidence to indicate the circumstances surrounding the transaction."
The liberal view raises the question of whether or not the parol
evidence rule operates against both the plaintiff and defendant
equally.78 Even though "it is elementary that most defenses necessarily rest in parol,"18 it is not so apparent that testimony which
"tends to vary the terms of the instrument," such as evidence that
(1923), aff'd, 283 Pa. 203, 129 Atl. 53 (1925) (check presumed to be collateral security);
City of Philadelphia v. Neill, supra note 63 (noteseven third partyare collateral
security, or at most conditional payment); United States v. Hegeman, supra note 63
(acceptance of new bill from acceptor after maturity for future payment is collateral
security).
72 Kessler, Levi & Ferguson, supra note 64.
73 The Uniform Commercial Code stresses form of negotiable instruments rather
than function. U.C.C.
3-104, -805.
74 U.C,C. 3-606(1) (b).
75 Economy Fuse & Mfg. Co. v. Standard Elec. Mfg. Co., 359 Ill. 504, 194 N.E.
922 (1935) (check indorsed as "accord and satisfaction").
76 Bell v. McDonald, 308 Ill. 329, 139 N.E. 613 (1923) (holder of promissory note
allegedly procured by fraud).
77 Feinberg v. Levine, 237 Mass. 185, 129 N.E. 393 (1921) (no evidence that
creditor treated as payment); Gehringer v. Real Estate-Land Title & Trust Co., 321
Pa. 401, 184 Atl. 100 (1936) (circumstances did not indicate contrary intent).
78 Britton, supra note 37, 51, at 200-03.
70 Id. at 201.
75
9 Wigmore, Evidence 2425 (3d ed. 1940) for definition of parol evidence
rule.
81 U.C.C. 3 - 605.
82 tr.C,C. 3-605(1)(b).
88 State v. Adams, 187 Ind.
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or that a debt was not paid by giving a note for a pre-existing indebtedness." The conflicting use of presumptions is illustrated by the fact
that in Indiana an appellate court held a promissory note gave rise
to the presumption of payment" while in New York, at approximately
the same time, it was held that a strong presumption arises that
the parties did not intend the debt to be extinguished by promissory
notes."
In cases involving payment by check, the weight of authority
is that a check does not raise the presumption of payment; it is
merely conditional payment. Yet, under the N.I.L., decisions are
by no means uniform. Other factors are considered significant, such as
whether certification was requested by the holder-creditor," whether
the creditor was guilty of laches,' whether the debtor was primarily
or secondarily liable on the instrument" and whether the instrument
was that of a third party."
The lack of uniformity in presumptions raised is indicated by
the New Jersey annotation to section 3-802 of the Code: "these rules
impress one as inconsistent and haphazard.' This comment refers
specifically to the presumption of payment arising where a third party
instrument is given concurrently with the creation of a debt. The
annotator describes this presumption as being continued under section
3-802(1) of the Code, and states, "that no good reason [exists] to
presume the parties presumptively have agreed to take the instrument
in discharge of the obligation . . . unless the underlying obligor is
not liable on the third party instrument," if he, for instance, transfers
the bill or note without indorsing it. Although presumptions are useful
in ascertaining court policy, they do not effectively serve to indicate
the basis for this policy.
87 Newhall v. Arnett, 279 Pa. 317, 123 Atl. 819 (1924) (suit against accommodation
maker of note).
88 Duvall v. Ransom & Randolph Co., supra note 85.
Bo Sedwitz v. Arnold, 164 Misc. 892, 299 N.Y.S. 848 (City Ct. 1937) (acceptance of
promissory note in payment of antecedent debt).
9 Tuckel v. Jurovaty, 141 Conn. 649, 109 A.2d 262 (1954) (third party check);
Baughman v. Lowe, 41 Ind. App. 1, 83 N.E. 255 (1908) (client accepted attorney's
check); Nason v. Fowler, 70 N.H. 291, 47 Atl. 263 (1900) (tax collector accepted check).
pi See generally 14 Wyo. L.J. 39 (1959).
92 Danks v. Kropp Steel Co., 21 Ill. App. 2d 252, 157 N.E.2d 694 (1959) (creditor
must return check offered as accord and satisfaction); Cochrane v. Zahos, 286 Mass. 173,
189 N.E. 831 (1934) (laches will effect discharge on postdated check).
93 Tuckel v.Jurovaty, supra note 90 (fact that debtor was indorser does not alter
liability); Carroll v. Sweet, 128 N.Y. 19, 27 N.E. 763 (1891) (if debtor secondarily liable,
failure of conditions precedent discharge him).
94 Contra, ibid (fact that instrument is that of third party does not alter result).
See Cox v. Hayes, 18 Ind. App. 220, 47 N.E. 844 (1897); Fleig v. Sleet, 43 Ohio St. 53, 1
N.E. 24 (1885); Wendkos v. Scranton Life Ins. Co., 340 Pa. 550, 17 A.2d 895 (1941).
95 N.J. Rev. Stat. 12A; 3-802 (1962).
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97
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not the equivalent of a payment, thus resulting in a complete forfeiture! Suretyship cases are rife with such logic. In Droege v. Hoagland
State Bank,142 the maker's father had signed as surety on an earlier
note, and his signathre was forged on a subsequent renewal note.
The bank-payee of notes given in payment of the earlier note sued
the father, who defended on grounds of release. The court held that
a good faith acceptance of a renewal note on which the signature of
the surety has been forged from the principal does not operate as payment of the original note so as to extinguish the payee's right of
action thereon despite the negligence of the payee.' It should be
clear from this discusion that a hard and fast rule dealing with preexisting indebtedness is at best another subdivision of judicial
presumptions which will not lend consistency to the law.
5. Negotiable Instruments as an "Accord and Satisfaction" of Underlying Obligations
One can also find language in some cases indicating that the
factor of whether a negotiable instrument was given for a liquidated
or unliquidated debt (accord and satisfaction) is significant in determining liability on the underlying obligation. For example, in Neher
v. Kerr, 104 a creditor sued a debtor on account. The debtor defended
that the debt was unliquidated and that the creditor had accepted a
negotiable instrument in a lesser amount. The court held that where
a bona fide dispute exists as to the amount due, and the creditor
accepts a negotiable instrument in full payment, the account is
discharged; the payment is not conditional. In the landmark case of
Fleig v. Sleet, 1" the plaintiff-vendor brought an action on account
and the defendant, an indorser of a third party check which was subsequently dishonored, defended that there was an accord and satisfaction. The court held that, although there was an accord as to the
amount of the unliquidated account, the delivery of a worthless check
was not satisfaction. The court added in obiter dictum that had delay
of presentment caused prejudice, a different question could have arisen.
Other cases indicate that where a negotiable instrument is given as
an accord and satisfaction, the creditor must accept it as such,"
Droege v. Hoagland State Bank, supra note 63.
Compare Emerine v. O'Brien, supra note 63 (forged note does not operate as
satisfaction of antecedent debt) with Droege v. Hoagland State Bank, supra note 63. Cf,
State v. Adams, supra note 83 (surety not released by renewal notes); Knight v.
Kerfoot, 184 Ind. 31, 110 N.E. 206 (1915) (surety released by renewal notes which she
did not sign) ; Kirchstein v. Dreazen, 128 Misc. 686, 219 N.Y.S. 697 (Munic. Ct. 1927)
(surety released by varying terms).
104 Neher v. Kerr, 70 Ind. App. 363, 123 N.E. 467 (1919).
103 Fleig v. Sleet, supra note 94.
106 Federal Cas. Co. v. Chatman, 69 Ind. App. 67, 121 N.E. 296 (1918) (insurer's
102
103
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116
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83
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(2)
139
U.C.C. 3 - 802(1).
140
U.C.C. 3-501(1)(b).
85
payment, the drawee bank dishonored the check, whereupon B refused to make the check good."'
From what has been stated thus far, A in the first hypothetical, and
and B in the second would be released as indorsers on the check
because of the unexcused failure to present the check for payment
within a reasonable period of time. 142 Furthermore, these parties would
also be discharged on their underlying obligation because section
3-802 (1) (b) provides ". . . discharge of the underlying obligor on
the instrument also discharges him on the obligation." (Emphasis
added.)
The official comment to this section states that a check or other
negotiable instrument is "conditional payment," i.e. ". . . taking the
instrument is surrender of the right to sue on the obligation until
the instrument is due; but if the instrument is not paid on due presentment, the right to sue on the obligation is 'revived."145 This
definition of conditional payment more closely follows the definition of
pro tanto discharge, and since discharge of the underlying obligor on the
instrument also discharges him on the obligation, the statute has
the effect of absolute payment."'
The comment does little to answer the issue posed in the hypotheticals as to why the indorser of a check has a preferred position. The
Code makes the rule (discharge of the indorser as opposed to discharge
of the drawer) turn on the meaningless distinction between a drawer
and indorser, and not on primary and secondary liability."' The confusion caused by this distinction is indicated by the comment of the
New York Law Revision Commission"' that "it is not clear . . . the
obligor on an underlying obligation would be discharged on that obligation by a discharge of his liability on the instrument resulting from
a failure of timely presentment or notice of dishonor." Research in
the other state comments to this section has not proved fruitful in
141 For the purpose of this article it is assumed that the delay in presentment for
payment does not result in waiver or excuse (neither A nor B knew that the drawer
was insolvent) ; and, therefore, the provisions of U.C.C. 3-417(2) are not applicable.
142 "Where without excuse any necessary presentment or notice of dishonor is
delayed beyond the time when it is due (a) any indorser is discharged. . . ." U.C.C.
3-502(1)(a). Presentment for payment must be within a reasonable time after the
indorser's indorsement to hold him liable, which is presumed to be seven days after
his indorsement. U.C.C. 3-503(1) (e), (2) (b).
148 U.C.C. 3-802(1) (b), Comment 3.
144 "Absolute payment" (merger) involves those situations in which the taking of a
negotiable instrument "merged" the underlying obligor's debt into the instrument, thus
making the instrument "absolute payment" of the debt.
148 N.J. Rev. Stat.
12A: 3-802 (1962), comments that this distinction "does not
impress the writer as being an improvement."
14e 2 N.Y.L. Rev. Comm. Study of the U.C.C. 445 (1955).
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resolving the issue raised by the first hypothetical, 147 nor does an
investigation of the official comments as to the reason for discharge
of an indorser due to the failure of timely presentment. Section 3-503,
Comment 3 of the Code indicates the policy behind discharge of the
indorser to be that "the indorser who has normally received the check
and passed it on, and does not expect to have to pay it, is entitled to
know more promptly whether it is to be dishonored, in order that he
may have recourse against the person with whom he has dealt."
(Emphasis added.) This comment begs the question. Even admitting
that the indorser does not expect to pay the check, it does not follow
that he expects to escape liability for the underlying obligation. Furthermore, an assumption that the indorser is entitled to prompt presentment
so that he can have recourse against a prior party only acknowledges
that where he is deprived of that recourse and is injured thereby, he is
entitled to discharge. This does not mean that the indorser should be
released on the instrument and from the underlying obligation when
he is not injured by the failure of timely presentment as in the case of
the hypothetical problem. As a matter of fact, the indorser probably
expects that if the instrument fails, he will have to pay for the underlying obligation!
B. Alternatives and Evaluation
Since the relationship of "liability on the instrument" and "liability for the underlying obligation" is not satisfactorily resolved by
section 3-802 (1) (b), an examination of alternatives is in order. The
hypothetical problems serve as a useful method of analysing and evaluating such alternatives.
1. The First Hypothetical Problem
In the first fact pattern there seems to be no just reason why
Indorser A should be discharged from the instrument and his underlying obligation. Even though A had the right to know promptly that
the check was dishonored, the notice would not have enabled him to
147 E.g., Cal. Commercial Code 3802, Comment 4:
Subparagraph (1)(b) provides that upon maturity of the instrument an
action may be maintained either on the debt or upon the instrument at the
option of the holder. Assuming an irrevocable election is contemplated, and this
is inferred in the comment following the section, it might be desirable to use
more explicit language to indicate precisely when and how such an election
is made;
Ind. Ann. Stat. 19 - 3 - 802 (1964), Comment:
Negotiable instruments frequently are given and received for an underlying
negotiable or non-negotiable obligation. Rules for determining when the underlying obligation is discharged or suspended are stated by this section. . . The
rules stated by this section are subject to contrary agreements which may be
important. to show either that a conditional discharge is unconditional or that
a pro tanto discharge is intended to serve as a total discharge.
87
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U.C.C. 3-414(0.
89
C. Amendment
To accomplish the desirable result suggested above, the following
amendment to section 3-802(1) (b) and the Comment thereto is
suggested:
(b) in any other case the obligation is suspended pro tanto until
the instrument is due or if it is payable on demand until its presentment. If the instrument is dishonored action may be maintained on
either the instrument or the obligation; DISCHARGE OF THE
UNDERLYING OBLIGOR ON THE INSTRUMENT ALSO
DISCHARGES HIM ON THE OBLIGATION TO THE EXTENT
OF HIS INJURY WHERE THE UNDERLYING OBLIGOR
HAS BEEN INJURED BY AN ACT OF THE HOLDER, BUT
THE UNDERLYING OBLIGOR IS NOT OTHERWISE DISCHARGED.
COMMENT
90